A V Rajwade: Rules vs principles

WORLD MONEY

The RBI would do better to use a light-handed approach.

One of the major debates regarding convergence of accounting standards internationally, is whether they should be rules-based or principles-based. The style and culture in the US, in respect of such regulatory documents, prefer extremely detailed rules, typically running into hundreds of pages. (If I remember correctly, the personal tax code runs to some 800-odd pages.) On the other hand, historically, the regulatory prescriptions in the UK are more principles-based rather than rules-based. When I went to London to work for a bank back in 1973, one of my culture shocks was to see Bank of England circulars starting something like, "We would advise banks against increasing their exposure to ...." "" not the kind of directives I was used to back home. Nevertheless, the old lady of Threadneedle Street remained a wise and effective supervisor of the banking system "" else, how could London have retained its prime importance as the world's largest foreign exchange and offshore money market, even in the days of extremely rigid exchange controls on residents?

Critics of rule-based regulations argue that they, in effect, provide a road map for circumventing them in spirit, without contravening them in letter. Some of the headline-making instances are the scandals in Enron and Worldcom, where too many professionals were content to comply with the wording, while merrily violating the intention behind the regulations. Principles-based accounting standards would, on the other hand, require company managements and auditors to ensure that the spirit underlying the principles is not violated, and hold them accountable should violations occur.

The provocation for these thoughts is the recent incident involving Naina Lal Kidwai of HSBC. Kidwai was refused recognition by the central bank, as chief executive of HSBC, because she was a director of Nestle SA, a Swiss company. It was perhaps unfortunate for the RBI that the news came out on the very day that the news about Indra Nooyi's appointment as CEO of PepsiCo in the US. In the minds on the common man, it brought into sharp contrast how Americans are happy to appoint an Indian origin woman as the head of a giant US company, while our own central bank puts spokes in another Indian woman's becoming a non-executive director of a big multinational company. Did the regulator's emphasis on the letter of the rules on conflict of interest, rather than the spirit behind them, lead to the seemingly odd ruling? Let me narrate two personal, albeit less newsworthy, experiences relating to two different regulators.

Some years ago, I was on the local advisory board of a major foreign bank. When my appointment came up for renewal, the RBI insisted that it would not agree to the renewal, unless I resign from the boards of other financial services companies. At that time, these happened to be Crisil, the rating company, and a Mauritius based open-ended fund investing in the Indian equity market. None of the three entities saw any conflict of interest in my continuing, but the RBI would not relent. Finally, I preferred to retire from the foreign bank's local advisory board rather than Crisil or the Mauritius company. I never understood the rationale.

More recently, I was invited to join the board of the trustee company of a major mutual fund, when I was a director of the AMC of another mutual fund: the promoters of the two funds had absolutely no connection with each other but Sebi refused to clear my name. The objection was not to my being a director of the AMC per se, but to my not being technically an independent director because I was doing some advisory work for the promoter of the AMC. I have never understood the relevance of this to my being on the board of the trustee company of a completely different mutual fund.

While Kidwai has decided to give up her Nestle directorship, the fact is that there are far bigger conflicts of interest in the management of the banking system. One is that the regulator nominates directors on the boards of public sector banks. This means that the RBI is both the regulator/supervisor, on one hand, and responsible for management also through its nominee directors, on the other. Similarly, the Government of India nominees also have objectives other than the bank's bottom line or the interests of all the stakeholders including the shareholders, employees and depositors. Such legitimate objectives often conflict with the political priorities of their masters, which then become the nominee directors' objectives.

But coming back to Kidwai, the RBI stand does not make sense. Surely, bankers will gain in experience and perspective by also being on the board of business enterprises? If conflict of interest was the worry, surely HSBC would have volunteered not to do any business with Nestle or its affiliates/associates in India? A greater emphasis on the spirit rather than the letter would surely have been useful.

Email: avrco@vsnl.com